More than 90 percent of American workers in their 50s don’t have a pension and 46 percent don’t participate in an IRA or 401(k) at work. A recent study found 4 in 10 middle-class Americans will likely live on or below the federal poverty line by age 65.1
Many experts say annuities may be appropriate for those facing the threat of running out of funds in retirement. An annuity is a contract purchased from an insurance company. It basically trades a certain amount of premium for the promise of income benefits that begin at a specific date in the future. The biggest advantage is the buyer can choose an option to receive lifetime benefits, ensuring a stream of income even if other assets are depleted — kind of like a back-up Social Security plan.2
We can help you determine if this lifetime income vehicle would make a good fit for your personal retirement plan. While your assets in an annuity may be invested in some form of mutual fund during the contract deferral period, an annuity is not technically an investment. That investment risk is assumed by the insurance company, while the contract owner benefits from future guaranteed income.3
An investor may or may not generate a higher return than if he or she invested the money on their own during the annuity deferral period. The advantage is annuities take away concerns about market corrections or an extended bear market during retirement. The annuity contract will guarantee a certain level of income at the specified date, so the retiree trades risk for secured income when it is needed.4
For those hesitant to commit a large portion of assets to purchase an annuity early in retirement, some annuity contracts offer another option in the form of dollar-cost averaging. This is the strategy of contributing smaller payments toward the contract throughout a period of time. Those payments will be invested regardless of market volatility, which means more shares are purchased when prices are low and fewer when prices rise.5
Long term, however, when the contract owner continues to purchase through various price levels, this strategy results in a lower average cost per share. Using this approach with an annuity contract that features an optional living benefit rider enables the owner to lock in guaranteed interest payments during a specific period of time.6
It’s worth discussing how annuities are taxed, particularly if you’re considering how to position retirement income for the future. If you use assets from a qualified retirement plan to purchase an annuity, the annuity becomes a qualified contract, and the owner pays the ordinary income tax rate at the time annuity payouts begin.7
If the annuity buyer uses unqualified money — such as that from a stock portfolio — to purchase the contract, it is considered a nonqualified annuity. When benefits begin in the future, the owner will pay taxes only on the portion of each payout that is deemed to be interest and earnings that were not subject to taxes throughout the deferment period.8
Be aware an annuity is a complex retirement option and there are many variations. This is good because different contracts are suitable for different situations, but it’s especially important that you work with a seasoned advisor who can help you determine if an annuity is a good option for your retirement portfolio. If so, the advisor will recommend which type would be most appropriate for you. We’re always happy to discuss these and other options with you.9
1 Paul Brandus. Marketwatch. Jan. 20, 2019. “Never mind the Social Security increase, seniors are in trouble — here’s why.” https://www.marketwatch.com/story/forget-the-social-security-increase-this-is-why-seniors-are-in-trouble-2018-10-16. Accessed Jan. 24, 2019.
2 Jack Guttentag. Forbes. Jan. 5, 2019. “How An Annuity Improves A Retirement Plan.” https://www.forbes.com/sites/jackguttentag/2019/01/05/how-an-annuity-improves-a-retirement-plan/#d8adfa863713. Accessed Jan. 24, 2019.
3 Bob MacDonald. Forbes. Jan. 4, 2019. “Annuities Explained (In Plain English).” https://www.forbes.com/sites/forbesfinancecouncil/2018/01/04/annuities-explained-in-plain-english/#550d1f55bd6a. Accessed Jan. 24, 2019.
5 Tim Seifert. Investment News. April 9, 2018. “Old strategy with a new twist: Dollar cost averaging and annuities.” https://www.investmentnews.com/article/20180409/BLOG09/180409939/old-strategy-with-a-new-twist-dollar-cost-averaging-and-annuities. Accessed Jan. 24, 2019.
8 Mark Henricks. Yahoo Finance. Jan. 4, 2019. “How Are Annuities Taxed?” https://finance.yahoo.com/news/annuities-taxed-231022800.html. Accessed Jan. 24, 2019.
Content prepared by Kara Stefan Communications
We are an independent firm helping individuals create retirement strategies using a variety of insurance and investment products to custom suit their needs and objectives. This material is intended to provide general information to help you understand basic financial planning strategies and should not be construed as financial or investment advice. All investments are subject to risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. The information contained in this material is believed to be reliable, but accuracy and completeness cannot be guaranteed; it is not intended to be used as the sole basis for financial decisions. If you are unable to access any of the news articles and sources through the links provided in this text, please contact us to request a copy of the desired reference.